Market Skimming, Market Penetration

14th November 2021 1 By indiafreenotes

Market Skimming

Price skimming is a price setting strategy that a firm can employ when launching a product or service for the first time. By following this price skimming method and capturing the extra profit a firm is able to recoup its sunk costs quicker as well as profit off of a higher price in the market before new competition enters and lowers the market price. It has become a relatively common practice for managers in new and growing market, introducing prices high and dropping them over time.

Price skimming is sometimes referred to as riding down the demand curve. The objective of a price skimming strategy is to capture the consumer surplus early in the product life cycle in order to exploit a monopolistic position or the low price sensitivity of innovators.

Price skimming happens when a marketer initially offers an item at a high price that consumers with the strongest desire and funds to purchase it will, and then as that demand is depleted the price gets lowered to the next layer of customer desire in the market.

Limitations of price skimming

  • It is effective only when the firm is facing an inelastic demand curve. If the long run demand curve is elastic (as in the adjacent diagram), market equilibrium will be achieved by quantity changes rather than price changes. Penetration pricing is a more suitable strategy in this case. Price changes by any one firm will be matched by other firms resulting in a rapid growth in industry volume. Dominant market share will typically be obtained by a low cost producer that pursues a penetration strategy.
  • A price skimmer must be careful with the law. Price discrimination is illegal in many jurisdictions, but yield management is not. Price skimming can be considered either a form of price discrimination or a form of yield management. Price discrimination uses market characteristics (such as price elasticity) to adjust prices, whereas yield management uses product characteristics. Marketers see this legal distinction as quaint since in almost all cases market characteristics correlate highly with product characteristics. If using a skimming strategy, a marketer must speak and think in terms of product characteristics to stay on the right side of the law.
  • The inventory turn rate can be very low for skimmed products. This could cause problems for the manufacturer’s distribution chain. It may be necessary to give retailers higher margins to convince them to handle the product enthusiastically.
  • Price skimming can attract more competition to the market due to firms intrigued by the high price margins and introducing their own product, also eroding the inelasticity of the demand curve.
  • Skimming results in a slower rate of product diffusion and adoption. This results in a higher level of untapped demand, giving competitors time to either imitate the product or leapfrog it with an innovation. If competitors do this, the window of opportunity will have been lost. The slower rate of adoption can also have an effect on brand loyalty as fewer customers get their hands on or are aware of the item being sold.
  • The manufacturer could develop negative publicity if they lower the price too fast and without significant product changes. Some early purchasers will feel they have been ripped off. They will feel it would have been better to wait and purchase the product at a much lower price. This negative sentiment will be transferred to the brand and the company as a whole.
  • High margins may make the firm inefficient. There will be less incentive to keep costs under control. Inefficient practices will become established making it difficult to compete on value or price.
  • The lower quantity demand for the item may mean a firm can not take advantage of economies of scale.

When considering a relatively new product with a limited supply and a short life cycle, price skimming can be introduced as a strategy during the first stage of the product life cycle, because some customers want to be the first to buy the product and are willing to pay the premium. Then the price will go down after a certain selling period, which is also referred to as market exit time.

Price skimming occurs for example in the luxury car and consumer electronics markets. In consumer electronics, there is a confounding factor that there is typically high price deflation due to continual reductions in manufacturing cost and improvements in product quality for example, a printer priced at $200 today would have sold for a far higher price a decade ago.

Market Penetration

Market penetration refers to the successful selling of a product or service in a specific market. It is measured by the amount of sales volume of an existing good or service compared to the total target market for that product or service. Market penetration is the key for a business growth strategy stemming from the Ansoff Matrix. H. Igor Ansoff first devised and published the Ansoff Matrix in the Harvard Business Review in 1957, within an article titled “Strategies for Diversification”. The grid/matrix is utilized across businesses to help evaluate and determine the next stages the company must take in order to grow and the risks associated with the chosen strategy. With numerous options available, this matrix helps narrow down the best fit for an organization.

This strategy involves selling current products or services to the existing market in order to obtain a higher market share. This could involve persuading current customers to buy more and new customers to start buying or even converting customers from their competitors. This could be implemented using methods such as competitive pricing, increasing marketing communications, or utilizing reward systems such as loyalty points/discounts. New strategies involve utilizing pathways and finding new ways to improve profits and increase sales and productivity in order to stay competitive.

Strategies

Price adjustments

One of the common market penetration strategies is to lower the products’ prices. Businesses aim to generate more sales volume by increasing the number of products purchased by putting on lower prices (price competition) for consumers comparing to the alternative goods. Companies may alternatively pursue strategies of higher prices depending on the demand elasticity of the product, in the hope that it will generate an increased sales volume and result in higher market penetration.

Penetration pricing

Penetration pricing is a marketing technique which is used to gain market share by selling a new product for a price that is significantly lower than its competitors. The company begins to raise the price of the product once it has achieved a large customer base and market share. Penetration pricing is frequently used by network provider and cable or satellite services companies. Many of the providers will initially offer an unbeatable price to attract customers into switching to their service and after the discount period has ended, the price increases dramatically and some customers will be forced to stay with the provider because of contract issues.

Penetration pricing benefits from the influence of word-of-mouth advertising, allowing customers to spread the words of how affordable the products are prior to business increasing the prices. It will also discourage and disadvantage competitors who are not willing to undersell and losing sales to others. However, businesses have to ensure they have enough capital to stay in surplus before the price is raised up again.

Increased promotion

Businesses can also increase their market penetration by offering promotions to customers. A promotion is a strategy often linked with pricing, used to raise awareness of the brand and generate profit to maximise their market share.

More distribution channels

A distribution channel is the connection between businesses and intermediaries before a good or service is purchased by the consumers. Distribution can also contribute to sales volumes for businesses. It can increase consumer awareness, change the strategies of competitors and alter the consumer’s perception of the product and the brand, and is another method to increase market penetration.

Product improvements

Product management is crucial to a high market penetration in the targeted market and by improving the quality of products, businesses are able to attract and out-quality the competitors’ products to match customers’ requirements and eventually lead to more sales made. Product improvements can be utilised to create new interests in a declining product, for example by changing the design of the packaging or material/ingredients.

Market development

Market development aims at non-buying shoppers in targeted markets and new customers in order to maximise the potential market. Before developing a new market, companies should consider all the risks associated with the decision including its profitability. If a company is confident about their products, believes in their strengths, and is enticing to new consumers, then market development is a suitable strategy for the business.